Mortgage Rates Forecast

By Cougar ConsultingRachel Sampalli: 800388245Mortgage Rate Forecast

OutlineIntroductionData DescriptionMethodologyEstimation ResultsForecast

Introduction

The VariableThe report forecasts 30 year fixed conventional mortgage rates for July 2010 through November 2010.

A fixed mortgage is a mortgage in which the interest rate does not change during the entire term of the loan. This is in contrast to adjustable mortgages where the interest rate can change based on inflation or other variables. Another component of a conventional mortgage is that it is not insured or guaranteed by the government.

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Mortgage Banking IndustryThe mortgage banking industry is an oligopoly. Big players include Wells Fargo, JP Morgan Chase, Bank of America and Citigroup.The 2008 financial crisis affected all four of these banks.

Hoovers. "Industry Overview: Mortgage Banking." Hoovers: a D&B Company. 2010. http://www.hoovers.com/mortgage-banking/--ID__176--/free-ind-fr-profile-basic.xhtml (accessed July 9, 2010).Wikinvest. "Bank of America (BAC)." "J P Morgan Chase (JPM)." "Wells Fargo (WFC)." "Citigroup (C)." Wikinvest. 2010. http://www.wikinvest.com/stock/Bank_of_America_(BAC) (accessed July 9, 2010).

the market is an oligopoly with the 50 largest corporations earning 70% of the revenue. Wells Fargo is the United States largest mortgage lender, servicing one in every seven mortgage loans in the U.S. With the acquisition of Wachovia it will have 16% of the market. JP Morgan Chase has the largest hedge fundBank of America is doing quite well.Citigroup was fourth largest lender, but that has since changed after the financial crisis.They all received government bailout TARP funds. All of them have since repaid it, except for ne but Citigroup has repaid their funds.

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How the Industry worksMortgage loans are used to finance homes.Interest rate is the cost of borrowing and acts as revenue to the bank.The original lender sometimes sells the loan in pieces of riskiness to a third party.The third party sometimes repackages the loan with other loans and sells it again, and so on and so forth.

As Im sure all you realtors know, many people do not have enough money to pay for their new homes out of pocket.Its what is put on top of the monthly repayment; so the bank or lender can make some profit.The original lender meaning the bank that originaally gave the loan. and the third party often meaning another bank or financial institution.This is called securitization.6

Data Description

Definition of Variables30 year fixed conventional mortgage rates is the dependent variable, what we are trying to forecast.Nominal 10 year maturity U.S. Treasury securities yield is the independent variable, what we are using to forecast mortgage rates.

These are the mortgage rates I was referring to earlier.U.S. Treasury yield is a type of government debt, issued by the treasury. The one we are discussing has a maturity of 10 years, its done in 10 years. Its nominal, its not including inflation. The reason why Im using this is because 10 year U.S. Treasury securities are used to set long term mortgage rates, its the benchmark.

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Data Source and CollectionBoth variables were taken from the Board of Governors of the Federal Reserve System. The time period of the data are from January 1990- June 2010.30 year contract fixed conventional mortgage rates are determined by the Primary Mortgage Market Survey conducted by Freddie MacNominal 10 year U.S. Treasury securities yield adjusted to constant maturities.Board of Governors of the Federal Reserve System. CONTRACT RATE ON 30-YEAR, FIXED-RATE CONVENTIONAL HOME MORTGAGE COMMITMENTS Market yield on U.S. Treasury securities at 10-year constant maturity, quoted on investment basisH.15 Selected Interest Rates for Jul 19,2010. ONLINE. 19 July 2010. Available: http://www.federalreserve.gov/datadownload/Download.aspx?rel=H15&series=74bef9826667028ac81f5468a626ef0e&filetype=spreadsheetml&label=include&layout=series [19 July 2010].Freddie Mac. "About the Primary Mortgage Market Survey (PMMS): About Freddie Mac." Freddie Mac. 2010. http://www.freddiemac.com/pmms/abtpmms.htm (accessed July 19, 2010).

Freddie Macs real name is Federal Home Loan Mortgage Corporation. Its government sponsered, created to increase the secondary market for mortgage rates, they securitize loans further.The primary mortgage market survey is a survey they do once a week by contacting about 125 lenders and asking them what their rates are. Adjusted to constant maturities meaning you can compare this to other bonds and yields, if they have the same maturity date. Investment basis meaning quoted in a way to measure your investment for tax purposes. 9

Mortgage Rates [January 1990-June 2010]Board of Governors of the Federal Reserve System. CONTRACT RATE ON 30-YEAR, FIXED-RATE CONVENTIONAL HOME MORTGAGE COMMITMENTSH.15 Selected Interest Rates for Jul 19,2010. ONLINE. 19 July 2010. Available: http://www.federalreserve.gov/datadownload/Download.aspx?rel=H15&series=74bef9826667028ac81f5468a626ef0e&filetype=spreadsheetml&label=include&layout=series [19 July 2010].

Looking at the graph you can see that mortgage rates have a downward trend, and their procyclical, meaning they decrease during times of recession [2007-2009]10

Monthly Mean of Mortgage Rates [January 1990-June2010]MonthPercentage PointsJanuary7.08February7.07March7.13April7.20May7.22June7.20July7.30August7.26September7.14October7.12November7.11December7.01

Board of Governors of the Federal Reserve System. CONTRACT RATE ON 30-YEAR, FIXED-RATE CONVENTIONAL HOME MORTGAGE COMMITMENTSH.15 Selected Interest Rates for Jul 19,2010. ONLINE. 19 July 2010. Available: http://www.federalreserve.gov/datadownload/Download.aspx?rel=H15&series=74bef9826667028ac81f5468a626ef0e&filetype=spreadsheetml&label=include&layout=series [19 July 2010].

On this table, you can see that monthly averages differ by only fractions of a percentage points, showing there is no monthly seasonality.11

Frequency of Mortgage Rates in Various Percentage Point Ranges [January 1990-June 2010]Board of Governors of the Federal Reserve System. CONTRACT RATE ON 30-YEAR, FIXED-RATE CONVENTIONAL HOME MORTGAGE COMMITMENTSH.15 Selected Interest Rates for Jul 19,2010. ONLINE. 19 July 2010. Available: http://www.federalreserve.gov/datadownload/Download.aspx?rel=H15&series=74bef9826667028ac81f5468a626ef0e&filetype=spreadsheetml&label=include&layout=series [19 July 2010].

This is the frequency of mortgage rates in various percentage point ranges. You can see, given the time period, its roughly bell-shaped, with the most popular interest rate between 6 and 6.5 percentage points. 12

U.S. Treasury Yield [January 1990-June 2010]Board of Governors of the Federal Reserve System. Market yield on U.S. Treasury securities at 10-year constant maturity, quoted on investment basisH.15 Selected Interest Rates for Jul 19,2010. ONLINE. 19 July 2010. Available: http://www.federalreserve.gov/datadownload/Download.aspx?rel=H15&series=74bef9826667028ac81f5468a626ef0e&filetype=spreadsheetml&label=include&layout=series [19 July 2010].

U.S Treasury securities yield also has downward trend and decreases during recessions [2007-2009]., 13

Monthly Mean of U.S. Treasury Yield [January 1990-June 2010]MonthPercentage PointsJanuary5.45February5.45March5.51April5.60May5.65June5.61July5.56August5.48September5.33October5.33November5.31December5.33

Board of Governors of the Federal Reserve System. Market yield on U.S. Treasury securities at 10-year constant maturity, quoted on investment basisH.15 Selected Interest Rates for Jul 19,2010. ONLINE. 19 July 2010. Available: http://www.federalreserve.gov/datadownload/Download.aspx?rel=H15&series=74bef9826667028ac81f5468a626ef0e&filetype=spreadsheetml&label=include&layout=series [19 July 2010].

one can see there does not appear to be monthly seasonality.

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Frequency of U.S. Treasury Yield in Various Percentage Points Ranges [January 1990-June 2010]Board of Governors of the Federal Reserve System. Market yield on U.S. Treasury securities at 10-year constant maturity, quoted on investment basisH.15 Selected Interest Rates for Jul 19,2010. ONLINE. 19 July 2010. Available: http://www.federalreserve.gov/datadownload/Download.aspx?rel=H15&series=74bef9826667028ac81f5468a626ef0e&filetype=spreadsheetml&label=include&layout=series [19 July 2010].

A bell shaped histogram showing the highest frequency of U.S. Treasury securities yield in the 4 to 5 percentage points range. 15

Mortgage Rates: Descriptive Statistics [January 1990-June 2010]The average mortgage interest rate has been 5.85 percentage points.The highest value of 6.76 percentage points occurred in July 2006.The lowest value of 4.74 percentage points occurred in June 2010.5.9 percentage points is the median.Board of Governors of the Federal Reserve System. CONTRACT RATE ON 30-YEAR, FIXED-RATE CONVENTIONAL HOME MORTGAGE COMMITMENTSH.15 Selected Interest Rates for Jul 19,2010. ONLINE. 19 July 2010. Available: http://www.federalreserve.gov/datadownload/Download.aspx?rel=H15&series=74bef9826667028ac81f5468a626ef0e&filetype=spreadsheetml&label=include&layout=series [19 July 2010].

Im not gonna put the whole output here but the main things to know are:

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U.S. Treasury Yield: Descriptive Statistics [January 1990-June 2010]The average U.S. Treasury Yield has been 3.44 percentage points.The highest value of 5.11 percentage points occurred in May 2006.The lowest value of 2.42 percentage points occurred in December 2008.4.15 percentage points is the median of U.S. Treasury yield.

Board of Governors of the Federal Reserve System. Market yield on U.S. Treasury securities at 10-year constant maturity, quoted on investment basisH.15 Selected Interest Rates for Jul 19,2010. ONLINE. 19 July 2010. Available: http://www.federalreserve.gov/datadownload/Download.aspx?rel=H15&series=74bef9826667028ac81f5468a626ef0e&filetype=spreadsheetml&label=include&layout=series [19 July 2010].

And here it is for the treasury yield17

Methodology

RegressionMortt= 0 + 1N10Tt + tMort stands for 30 year fixed conventional mortgage rateN10T stands for nominal 10 year maturity U.S. Treasury securities yield.Since 10 year U.S. Treasury securities yield are used to set long term mortgage rates, we expect the coefficient for treasury yield,[1], to be positive.Nielsen, Barry. "How Interest Rates Affect The Housing Market." Investopedia. 2010. http://www.investopedia.com/articles/pf/07/mortgage_rate.asp (accessed July 21, 2010).Mortgage-X. "Treasury Market and Mortgage Rates." Mortgage-X: Mortgage Information Service. 2010. http://mortgage-x.com/general/treasury.asp (accessed July 23, 2010).

I used a regression.Mort, is the mortgage rates, our dependent variable, what were trying to forecastThen weve got a constant, beta-0.Weve got the treasury yield[N10T], multiplied by a coefficeint [beta-1]And then weve some error terms on the end. 19

Mortgage Rates & U.S. Treasury Yield [January 1990- June 2010]30 yr Fixed Mortgage Rates is based upon data taken from Board of Governors of the Federal Reserve System. CONTRACT RATE ON 30-YEAR, FIXED-RATE CONVENTIONAL HOME MORTGAGE COMMITMENTSH.15 Selected Interest Rates for Jul 19, 2010. ONLINE. 19 July 2010. Available: http://www.federalreserve.gov/datadownload/Download.aspx?rel=H15&series=74bef9826667028ac81f5468a626ef0e&filetype=spreadsheetml&label=include&layout=series [19 July 2010].Nominal 10 yr Treasury Securities Yield is based upon data taken from Board of Governors of the Federal Reserve System. Market yield on U.S. Treasury securities at 10-year constant maturity, quoted on investment basis H.15 Selected Interest Rates for Jul 19, 2010. ONLINE. 19 July 2010. Available: http://www.federalreserve.gov/datadownload/Download.aspx?rel=H15&series=74bef9826667028ac81f5468a626ef0e&filetype=spreadsheetml&label=include&layout=series [19 July 2010].

This is a scatter graph showing the relationship between mortgage rates and treasury yield. 20

Estimation Results

EstimatesTable 7 in the appendix summarizes the results of the regression.As U.S. Treasury yield increases by one percentage point, all else constant, mortgage rates increase by .78 of a percentage point.

Hypothesis TestsThis regression accounts for the fact that the error terms do not have the same variance.This regression accounts for the fact that error terms are serially correlated.After the regression is estimated with a one month lag, there is no longer trend in the data.An increase in U.S. Treasury yield causes an increase in mortgage rates.

Meaning the error terms are not spread evenlySerially correlated meaning, last months error term, is related to next months error term. So to fix that I put a one month lag in.As I said previously its a .78 percentage point increase, for every 1 percentage point of the treasury yield. I did a little test just to make sure thats the case.

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Measures of FitThis regression model accounts for 99% of the variability in mortgage rates. For the time period given, this model has an average error of about .07 percentage points or about 1%.

The Forecast

Mortgage Rate Forecasts[July 2010 - November 2010]Forecast [in percentage points]July 20104.75August 20104.76September 20104.77October 20104.78November 20104.78

Developing the ForecastTo develop this forecast I used the regression model in Table 7 of the appendix using real data and exploited the patterns to determine a forecast for future mortgage rates [July 2010 to November 2010].

Mortgage Rates: Actual and Forecast Values [January 1990-November 2010]Actual Mortgage Rates is based upon data taken from the Board of Governors of the Federal Reserve System. CONTRACT RATE ON 30-YEAR, FIXED-RATE CONVENTIONAL HOME MORTGAGE COMMITMENTSH.15 Selected Interest Rates for Jul 19,2010. ONLINE. 19 July 2010. Available: http://www.federalreserve.gov/datadownload/Download.aspx?rel=H15&series=74bef9826667028ac81f5468a626ef0e&filetype=spreadsheetml&label=include&layout=series [19 July 2010].Forecast mortgage rate is calculated using the regression model reported in Table 7. Actual Treasury securities yield for January 1990 through June 2010 is based upon data taken from Board of Governors of the Federal Reserve System. Market yield on U.S. Treasury securities at 10-year constant maturity, quoted on investment basis H.15 Selected Interest Rates for Jul 19, 2010. ONLINE. 19 July 2010. Available: http://www.federalreserve.gov/datadownload/Download.aspx?rel=H15&series=74bef9826667028ac81f5468a626ef0e&filetype=spreadsheetml&label=include&layout=series [19 July 2010]. Treasury securities yield for July 2010 through November 2010 based upon Holts exponential smoothing forecast in Table 12.

RecommendationsMortgage rates are expected to increase slightly, comparing Junes actual mortgage rate of 4.74 percentage points to Novembers forecast of 4.78 percentage points. I recommend encouraging customers to buy their new home now before the cost of borrowing increases.